Is Your Boss Really Your Boss?
When it comes to good debt versus poor debt, let me repeat what rich dad often said to me, “Every time you owe someone money, you become an employee of their money.”
That is, if you take out a 30-year loan, you’ve instantly become a 30-year employee for the bank. Unfortunately, they do not give you a gold watch when the debt is paid back.
Rich dad did borrow money, but he did his best to not become the person who actually paid for the loans.
That’s the key.
His advice bears repeating: Good debt is debt that someone else paid off for you, and poor debt was debt that you paid for with your own sweat and blood.
His love of rental properties was based on “the bank gives you the loan, but your tenant pays it off for you.”
Let me use a typical real-life example to illustrate just how this works.
Buying a House
Assume that you find a nice little house for sale in a decent neighborhood. True, the home needs some fixing up—perhaps a new roof, new gutters, and maybe a new paint job.
But by and large, it’s surrounded by other homes that are fairly well maintained, the neighboring area is solid, and the schools are good.
Even better, the neighborhood is right next to a local state university which is always looking for more student housing as the campus enrollment continues to increase year after year.
The homeowner wants to retire and move to someplace warm and sunny.
He’s asking $110,000 for his house. You negotiate a bit with him, and you finally settle on a price of $100,000. You already have $10,000 saved up in your bank account, so you need to get a mortgage for at least $90,000. But in truth, since that $10,000 is pretty much all the cash you have on hand, you decide to apply for a $100,000 mortgage.
Why? Because with that additional $10,000, you can pay off the bank’s closing costs as well as pay a local handyman to paint the house and repair the roof and gutters.
In many cases, the bank will be happy to give you the mortgage. Why? Because the mortgage is secured by the collateral value of the house.
If you went to a bank and asked for a loan of $100,000 and you didn’t have any collateral or secured assets to back it up, the bank would tell you to take a hike. But with the house property backing you up, the bank will usually help you finance the loan.
Remember, the bank is in the business of making loans—and will do so when they know that there’s real collateral to help secure that loan.
Dealing with the Bank
Let’s move on. Under current finance rates, the bank gives you a 30-year mortgage at a rate of 4.5 percent. First, of course, they want that $10,000 cash as a down payment, which you give them. So, in addition to the $100,000 mortgage, your total investment is now $110,000.
Once you figure in your property taxes, your monthly mortgage payment is going to be about $700. But as mentioned before, you don’t want to be an employee of that bank loan for the next 30 years. As long as you have that debt service, you’re working for the bank. The better approach is to have someone else pay off that debt for you.
Rich dad would suggest that, once you close the deal and own the home, you then start talking to the local university about the possibility of students renting your home.
Let’s say that you charge $1,000 a month for the rent. If the home has four bedrooms, it could easily accommodate four students, each of whom would pay $250 a month. That’s a fairly modest amount, even for the most cost-conscious student.
Or, you can simply check with a local real estate agency to see if they can handle the rental of your property. For a small monthly maintenance fee, many real estate agencies will not only find a renter for your property but will also take care of any minor maintenance issues, such as fixing a clogged toilet.
The Real Estate Domino Effect
Here’s more good news. If your rental property is earning you $1,000 a month, and your mortgage payment is only $700, then your monthly net cash flow is $300 a month. This net income is what is known as passive income.
That is, you’re not doing any heavy lifting or hard labor to earn it. At the same time, someone else, your tenant, is paying off your 30-year mortgage for you, and you’re earning an extra $300 a month.
One of the best things about cash flow is that you don’t need to acquire hundreds of thousands of dollars in savings in order to reach fiscal freedom. That’s because cash flow breeds more cash flow.
Kim’s first cash-flow investment (in 1989) was a small two-bedroom, one-bath house in Portland. Her monthly cash flow averaged a whopping $50. It wasn’t much, but it gave her a start.
There comes a point in your investing process where the cash flow from your investments supports not only your living expenses, but also your next investments. Your cash flow breeds new assets, which, in turn, breed more cash flow. Isn’t that spectacular?
Rich Dad’s Investing Philosophy
Rich dad’s real estate investing philosophy is primarily based on cash flow. Do you have positive cash flow at the end of each month?
There is also the possible bonus of appreciation. While you’re earning that extra income each month, you’re also paying down your mortgage each month. That means that, very slowly but steadily, you are building more equity into the home.
Since real estate properties may gain in value over time, your original investment of $110,000 in that home may also be appreciating in value. In other words, if 10 years from now you decide you want to sell the home, the market value of the house might have gone up to $125,000.
So, on paper, you would make a nice tidy profit of $15,000 from the sale of the house as well as all the passive income you collected.
Make passive income your ultimate goal.
Editor, Rich Dad Poor Dad Daily